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Towers Watson created a minor buzz on the news wires with a press release summarizing a study that found that the performance of defined benefit (DB) plans exceeded that of 401(k)/defined contribution (DC) plans in 2007 and 2008. One of the first items mentioned as a source of the outperformance is the quality of the professional management of the larger DB plans.  

Anyone perusing the many articles that carry snippets of this release might easily come away with the belief that the vast array of investment talent (the aforementioned professional management) proved its worth in the recent bull and bear markets by delivering solid outperformance. A cursory glance at the actual numbers, however, gives a different perspective:

Median return of DB plans in 2008: negative 25.27%

Median return of DC plans in 2008: negative 26.20%

In the worst bear market any practicing member of the investment consulting community has seen in their lifetime, the release is touting the fact that the professionally managed DB plan universe lost about 1% less than the DC universe. This might be more impressive if we weren't talking about only losing 25% as a victory. It's also worth noting that Towers Watson had only 79 plans in this 2008 sample.

What about the bull market of 2007? Perhaps the true upside of professional management shows through in an up market?

Median return of DB plan in 2007: 7.71%

Median return of DC plans in 2007: 6.78%

No, it appears that the differential is almost exactly the same: a little less than 1%. Does a deeper dive into the data reveal the true upside to the sophisticated investment management that dominates DB plans?

Towers Watson summarizes the overall findings as follows, "After stronger performances by DB plans during the 2000-2002 bear market, 401(k) plans outperformed DB plans from 2003 through 2005, as measured by plan-level medians. DB plans and DC plans realized equal returns in 2006, with 401(k) plans taking the lead again in 2007. But over the 13-year period, which captures both bull and bear cycles, DB plans outperformed 401(k)s by an average of 23 basis points."

You read that correctly. 23 basis points (or 0.23% for those not making a living in the financial industry) is the average differential between returns in the DB and DC arenas over the past 13 years.

Towers Watson explains what they see as largesse in outperformance by stating that, "DB plan trustees have a fiduciary responsibility for investment performance. They or the professionals they hire usually have considerable financial education, experience and access to sophisticated investment vehicles — advantages 401(k) plan participants typically lack."

I couldn't agree with them more. The average 401(k) investor can't adequately explain the difference between a stock and a bond much less attempt to replicate the nuances of a menu that encompasses alternative asset classes.

I also agree that the average 401(k) investor has no formal investment training and does not typically hold a degree in finance or mathematics. Comparing the investment pedigree of a high-paid investment consultant to a rank-and-file 401(k) participant is akin to comparing a professional tennis player to someone who has played badminton (twice, badly). If our badminton player is able to force the tennis pro into a five-set marathon and only loses in the tiebreaker, I'm not sure that the pro would turn around and pen an article touting the depth and breadth of their skills and expertise. It's more likely that the pro would attempt to buy any electronic evidence of the match and drop it into the deepest hole he/she could find.

Instead, we have a situation where 23 basis points of outperformance has been not-so-subtly held out as evidence of the value of professional management.

I think it's probably better to look at DB and DC plans as two different worlds with too many variables to justify a meaningful comparison. I also believe that there are a few investment consultants that have indeed proven their worth over the years – and that the rest of the folks practicing in that arena should be grateful they're around as the work of those few may be the only reason that the 23 basis point upside exists.

In the meantime significant dollars are being spent attempting to educate the masses within 401(k) plans so that they can one day overcome their shortcomings and perhaps eat in to that 23 basis point deficit in future versions of this study. The study throws a little cold water on future DC outcomes by stating that, "Even given more investment education and prudent default settings, however, DC plans will never replicate all the advantages of DB plans."

There go the 23 basis points...

Marshall J. Cobb, CRSP, is president and founder of Cobb Retirement Solutions, LLC., an independent, fee-only firm offering qualified plan analysis and oversight exclusively to corporations and organizations. Cobb's first-hand knowledge as a veteran representative of retirement plan vendors beginning in 1990 gives him a unique perspective as he advises his clients. Cobb runs his office -- based in Houston, Texas -- with employees and clients across the country.